Canadian dollar options offer value as event risk looms

TORONTO (Reuters) - Canadian dollar options offer value after implied volatility, used by traders to price options on the currency, cheapened and oil rose above $50, while events loom that could trigger uncertainty in currencies over the coming months, dealers said.

A Canadian dollar coin, commonly known as the "Loonie", is pictured in this illustration picture taken in Toronto January 23, 2015. REUTERS/Mark Blinch

Corporate accounts and institutional investors use options to hedge their currency exposure. Speculators also use them to make bets on the currency. Their value tends to increase as volatility in the currency rises.

Implied volatility for three-month options hit 9 percent on Tuesday, its lowest this year, after trading at 11.5 percent just over one month ago. It was at 9.45 percent on Thursday.

It has become cheap for importers to buy “protection” after recent strengthening in the loonie, said Don Mikolich, executive director, foreign exchange sales, at CIBC Capital Markets, who advocates buying options with a three- or six-month maturity in case the U.S. Federal Reserve raises rates in the coming months.

In addition to the Fed interest rate decisions, an upcoming event that might trigger volatility in the currency market is the UK Brexit vote later this month, dealers said.

Oil and stocks, which are major drivers of direction for the risk-sensitive commodity-linked Canadian dollar, are sitting at “big inflection points,” said Patric Booth, head of trading at Velocity Trade.

He thinks Canada’s employment report on Friday may also trigger a big move in the loonie if the data is negatively impacted by the recent wildfires in Alberta.

The Bank of Canada has indicated that the economy likely will shrink in the second quarter as a result of damage from the wildfires before rebounding later in the year.

Booth has bought an option on the Canadian dollar that expires after the employment data, hoping to benefit from a spike in volatility.

Dealers agree that a buildup of long positions in the Canadian dollar could add to volatility if the currency sells off.

Speculators have established the largest net-long position in the Canadian dollar in three years, data from the Commodity Futures Trading Commission has shown.

Meanwhile, corporate accounts who sold implied volatility to reduce their cost of hedging have taken advantage of the move lower to buy it back, said Brad Schruder, director of corporate sales and structuring at BMO Capital Markets.

In expectation that markets will remain uncertain, accounts have been active on “minor dips” in volatility, he added.